The Unique Quandaries Faced in Recovering International Cryptocurrency Frauds

What is Cryptocurrency?

Cryptocurrency itself is a string
of computer-generated code. This line of code is accessed by
an owner's unique passcode secret private key. Each owner's
cryptocurrency is kept in their "Virtual Wallet". Virtual wallets
are similarly anonymous as are the virtual currency balances. The
transfer of cryptocurrency is based upon the block chain protocol,
a public decentralized ledger that identifies transactions by a
digital code with no link to a person or place.

Practically, there is no public
record of virtual currency transfers. Other than the debtor's
own testimony, a creditor would not know where to begin searching
for evidence of virtual currency purchases or transactions. There
is no way for a creditor to identify either the owner or location
of a transferee's cryptocurrency address. In some cases, the debtor
could honestly state that he does not know the identity of the
individual who received his cryptocurrency transfers.

Cryptocurrency and Asset Recovery

For asset protection purposes, a
cryptocurrency account currently functions similarly to offshore
banking prior to the IRS's crackdown of anonymous personal foreign
accounts. Today, it is almost impossible for U.S. citizens to
establish an anonymous bank account, or any type of bank account,
outside of the U.S. With the advent of Bitcoin, a U.S. citizen can
open and maintain a financial account that has creditor protection
features similar to an offshore bank account in that the Bitcoin
account is anonymous and can be maintained outside the geographical
jurisdiction of domestic courts. Since block chains are
decentralized, they are not subject to any central authority (such
as a bank or other financial institution) that might be legally
compelled to provide a court with access or control over assets in
its possession. Without the complete private key, no court or legal
authority can manipulate ownership of a block chain asset.

At the moment, creditors face
obstacles of identifying potential defendants and the international
nature of the transaction. Properly selected offshore
fiduciaries holding accounts are unlikely to become subject to the
jurisdiction of a court where a defendant may be sued. Absent
jurisdictional authority, a court is powerless to compel the
fiduciary to turn over assets. Similarly, a US court could try to
compel the party to turn over the account or information about the
transaction. The court's contempt powers could be used to coerce
compliance. Arrest and incarceration can be utilized. See In Re
Lawrence, 279 F.3d 1294,1300 (11th Cir. 2002);
FTC v. Affordable Media Inc., 129 F.3d 1228, 1229
(9th Cir. 1999). But, on cruel and unusual punishment
grounds, incarceration cannot be imposed forever. If the asset is
more important than personal freedom, a court's power of compliance
is limited.

Crypotocurrency Remedies?

There are two equitable remedies
that exist under English common law which could be flexibly applied
to these evolving transactions. One existing remedy is the
equitable pre-trial discovery device known as a Norwich Pharmacal
order requiring third parties to disclose information to
potentially identify the wrongdoer, to trace funds and to assist
prospective plaintiffs in determining whether a cause of action
exists. (There are five states in the U.S. that also allow
for pretrial discovery to identify the wrongdoing.) Norwich
orders, being a flexible tool of equity, could assist in claims
involving cryptocurrency transactions. It may be possible
that identification information might come from "know your
customer" information given a bitcoin exchange. Proceedings
could be constituted as "the bitcoin holder with the public key
number…" However, the hurdle still exists to identify the
wrongdoer.

The second equitable remedy is
injunctive relief. Courts have granted world-wide
injunctions, particularly when the impugned conduct is occurring
online and globally, such as the internet. In Google Inc.
v. Equustete, 2017 SC 34, the Supreme Court of Canada recently
held that injunctive relief can be ordered against somebody who is
not a party to the underling lawsuit, even if that third party is
not guilty of wrongdoing. Google was ordered to stop
displaying search results globally for any Data Link
websites. "The problem in this case, is occurring online and
globally. The internet has no borders; its natural habitat is
global. The only way to ensure interlocutory injunction
(order) attain its objection was to have it apply where Google
operates - globally." Thus, if the third party to the block
chain transaction can be identified, there may be a remedy to
discover information and wrongdoing.

Therefore, courts will need to
apply not only new remedies, but expand existing ones. While
the identities of the buyer and seller are encrypted, a transaction
record is maintained on the public ledger. In the future,
anti-money laundering laws and cryptocurrency exchanges may require
the collection of personal data of customers. Until then, the
challenge of recovery will require creativity and
experience.

This Blog/Web Site is made available by the lawyer or law firm publisher for educational purposes only as well as to give you general information and a general understanding of the law, not to provide specific legal advice. By using this blog site you understand that there is no attorney client relationship between you and the Blog/Web Site publisher. The Blog/Web Site should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.

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Welcome to HMB's SALT & Pepper blog. As the title suggests, this blog tracks important and emerging issues, trends and developments that affect our clients not only in State and Local Tax (SALT) but also in other disciplines and industries. This blog is designed to be a helpful resource. We hope our readers will find it practical, insightful and valuable.